‘Triffin’s-Dilemma’: Why Smaller U.S. Deficits Are Increasing Global Fragility
Many pundits are talking about the U.S. government’s soaring debt levels. Which just surpassed $31.4 trillion as of Tuesday.
And while this is certainly troubling – the U.S. deficit has come down significantly over the last year.
In fact – the U.S. budget deficit saw a record decline thanks to surging tax-receipts and a huge decline in stimulus needs.
To put this into perspective – the U.S. deficit will be roughly $1.4 trillion less compared to last year. And also $400 billion less than officials expected back in March.
And while this is considered a ‘good’ thing (i.e. less government debt) – it comes with a very costly catch. . .
I’m talking about the U.S. being held to ‘Triffin’s Dilemma’ and the fragility it creates globally.
But first – here’s some context.
Triffin’s Dilemma – named after economist Robert Triffin – is a term showing the paradox between having a global reserve currency and domestic deficits/surpluses.
Triffin’s original issue was with Bretton Woods (aka the post-World War Two dollar-gold monetary system). And how it exposed a fundamental flaw in the international monetary system.
In summary: Triffin testified to congress in 1960 that the U.S. was stuck in a ‘Catch-22’ (aka a problem for which the solution is denied because of another inherit problem).
Putting it simply – if the U.S. stopped running budget deficits (or ran a surplus) – then the global economy would lose its main source of liquidity (aka U.S. dollars – the reserve currency). And this shortage of liquidity would increase global fragility and sink growth.
(Remember: since the U.S. dollar was the reserve currency backed by gold, foreign nations needed to first gain dollars to build up their own reserves. Then later exchange for gold if they wished. Thus the U.S. must constantly run deficits to export dollars globally).
But – on the other hand – if the U.S. continued running deficits to supply the world dollars and economic growth, it would erode the confidence in the dollar. And lead to a run-on U.S. gold supplies (since ever-more dollars outstanding are claims on the ever-finite amounts of gold). Thus – the dollar’s value as a reserve currency would diminish, leading to further fragility and disorder.
See the problem?
The U.S. government tried to fight this paradox for over a decade.
Why? Because it was enjoying the benefits of freely spending money. Thus exporting inflation globally through huge deficits. (For example: President Johnson’s ‘Guns and Butter’ policy for funding both the domestic ‘war on poverty’ and Vietnam were wildly expensive).
Until eventually – it was too late. . .
Thus in 1971 – eleven years after Triffin testified – President Nixon suspended the dollar-to-gold window (effectively ending Bretton Woods) to prevent further gold-outflows.
So in the end – Robert Triffin’s monetary ‘dilemma’ proved accurate.
Now – while Triffin’s-Dilemma was originally based on the dollar-gold fixed exchange system (Bretton Woods). I believe it still holds true today.
That’s because even in a fiat-based monetary system (aka money not backed with convertibility) – the U.S. dollar acts as paper ‘gold’.
Foreign nations still require dollars to build up their own reserves. And they do so in droves.
For instance – the U.S. dollar’s share of global currency reserves is at roughly 60%.
And U.S. federal debt held by foreigners and international investors sits at over $7.4 trillion.
(Notice how after the 1997 ‘Asian-Contagion’ crisis – when financial fragility spread globally throughout emerging markets – foreign nations began buying huge amounts of dollar-assets. Because these foreign nations wanted a chest of dollar-reserves to prevent another insolvency-crisis like 1997).
Meanwhile, the dollar continues soaring in value – hitting a 20-plus year high – due to ever-rising demand.
So – it’s clear that the U.S. dollar’s still regarded as the safest and most liquid asset for global reserve holdings.
Just as gold was pre-1970’s.
And this is why Triffin’s-Dilemma is still very relevant. . .
For instance – take a look at U.S. balance-of-payments over the last 70-years (when Bretton Woods first began).
There’s a trend between U.S. federal surpluses (or declining deficits) and recessions (grey-shaded lines in the chart).
For example – rising U.S. surpluses/declining deficits preceded the following:
The 1949 recession. The 1953 recession. The 1960-61 recession. The 1969-70 recession. The 1980 recession. The early-1990’s recession. The late-1990’s global recession/financial crisis. The early-2000’s recession. The Great 2007-09 recession. The 2014-16 global slowdown. And many others.
Again – just as Triffin explained: when the U.S. would curb dollar outflows through diminishing deficits/increasing surpluses – there’s a drain on global liquidity and also weighs down growth. (And vice-versa).
Put simply – it was starving the world of the very liquidity it needed to generate growth and off-set liabilities. . .
So – why am I worried about global fragility currently?
Because as I stated at the beginning – U.S. deficits are sinking very fast in year-over-year terms. And are currently back at 2019 levels.
And as I’ve written about before – it’s the rate-of-change (aka RoC – the percentage change) that matters most. Because it shows the magnitude of acceleration or deceleration; thus driving momentum.
And currently there’s a very sharp deceleration in U.S. deficits. Indicating a slowdown in dollar liquidity and global growth – according to Triffin’s-Dilemma.
Thus – both financial markets and the global economy face mounting downside and fragility. . .
So – in summary – while many pundits cheer for declining U.S. deficits, it’ll unfortunately amplify instability in global markets.
As we learned from Triffin – the U.S. controls the global reserve currency (the dollar). And thus must supply liquidity to all those that demand it by running larger deficits.
But when the U.S. runs surpluses (or simply smaller deficits), it drains liquidity from the system. Creating pockets of illiquidity, fragility, and anemic growth.
This is a true catch-22 in the current global monetary system:
Either the U.S. runs a balanced budget, yet the world economy suffers.
Or the U.S. runs ever-greater deficits, fueling global liquidity and growth. But at the risk of the domestic economy through rising debt and eroding confidence in the dollar’s reserve status. . .
There’s of course more to it. And many variables impacting the global economy.
But – for now – as U.S. deficits decline, I expect further downside in the global economy (as I’ve highlighted recently). And especially as the Federal Reserve aggressively tightens – creating greater negative ripple-effects.
The black swans (aka unforeseen and dramatic events) are lurking.
Editor at Speculators Anonymous